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When coming for accounts receivable factoring, one of the first matters to attend to is whether the company has any current financial arrangements – do you have any outstanding loans? Having a bank loan that is secured by your business assets will legally prohibit a factoring facility to go forward…. unless;

1. The loan was secured by the owners’ real estate, then the bank might have overstepped their security position by encumbering the operational assets. There is a chance of having the bank terminate their UCC-1 filed against the company accounts receivable.
2. There are enough current accounts receivables to pay off an existing loan at closing.
3. The bank is willing to do some sort of inter-creditor agreement whereby the factoring would be carved out to allow for first position security on the receivables being financed.

The reason for all of this is based on the security position of the asset. With factoring, you are essentially financing your accounts receivable and we must have the certainty that payments made on invoices be used to pay off advances made against them. We can’t finance an invoice and have the bank collect the payments.

Additionally, a careful reading of any bank loan documents will reveal that one of the conditions on the loan would be to prohibit borrowing any capital against the collateral used to secure the loan. In other words the bank does not want their collateral to be weakened by selling off parts of it. It usually is immediate grounds for default on the loan.

So while having an existing line of credit with a bank won’t necessarily preclude using factoring, it would require circumstances to allow it to move forward.

For the most part, a factoring company will be limited to purchasing invoices that never age more than 90 days. Accounts receivable financing typically is for businesses that issue 30 day net term invoices and have a history of getting paid in a timely manner. A business model that features bi-annual or annual payments will not be suitable for invoice factoring. Trying to cash out an annual contract with a factoring company is also not within the factoring capability.

The reason for this has to do with the arrangement a factoring company has with its funding source, usually an institutional bank. The bank has a facility to lend money to the factor who in turn makes capital advances to their clients. When the bank is calculating the available credit it issues to the factoring company, all outstanding invoices that have aged over 90 days may be considered a non-performing asset and therefore are deducted from their available credit line. So having over 90 day aged invoices can be detrimental to the factors availability, thus strategically important.

Now there are cases where an errant invoice does go over 90 days. In these situations a recently finished job with a new invoice is swapped to pay off the overdue invoice.

An important distinction to remember, the clock at the factoring company starts on the day of funding, not the date on the customer’s invoice. So a client may choose to submit an invoice to their customer and then hold and wait for a period of time (week or two or three) before submitting it to the factor for the advance. Thus avoiding possible extra fees associated with normal factoring.

Pledging something of value as a form of collateral to borrow money is creating a debt. Using debt is an instrument of industry. There is nothing dishonorable about acquiring an obligation if the proper planning and execution of that plan are done well.

There came a time when lenders decided there had to be some universal rules regarding how debt is administered. They figured out it would be a problem if someone used their collateral one day to borrow money and then turned around the next day and used the exact same collateral to borrow more.

Over time the universal rules became codified into what is now called the Uniform Commercial Code or UCC for short. It basically has two purposes;

1. The UCC is a gatekeeper giving all lenders notice that specific collateral has been pledged for a loan. Any other lender will see whether a company has used any portion of their business assets as the security for a loan. The new lender can then decide whether they want to move forward with another loan, knowing a lender will be paid off before them in order of date of filing.

2. The UCC instructs the court in case of a liquidation bankruptcy who has priority as a secured party to the remaining assets which are being liquidated. Hypothetically, a secured lender in first position on a UCC filing will be paid in full before any other creditor gets paid.

What does this mean to you?

Fundamentally you must know your UCC status at all times. Surprisingly few business owners know what the UCC is and who might have filed one against their company. You should be asking in any situation where credit is being issued how the lender is going to process it with regards to the UCC. They are called financing statements and they are registered at the Dept of Taxation in the State where the company is registered.

Because of the gatekeeper nature of the UCC, knowing if someone or someone’s are blocking the gate is a handy piece of knowledge. It’s as important as knowing your personal FICO score. For example, you may have an active UCC filed by a lender for a loan you paid off years ago. Having it removed requires you to contact that lender to have it terminated.

In many States you can look up your status at your State.gov website under the business section.

Comparatively speaking, receivable factoring is relatively quick easy process to set up. It begins with an application which needs to be filled out. Some factoring companies require an application fee, others, like us, do not. Along with the application and a copy of your current AR aging report we can offer you a no obligation proposal with the terms & conditions of your factoring deal. Remember the rates for invoice factoring depend largely on the creditworthiness of your customers, and the dollar volume of business being generated.

Creating an account can be exceptionally fast if the factor and the business cooperate with producing the proper documentation. The amount of documentation required is related to the complexity of the business model and history of the company. If getting a clear secured interest on business assets requires untangling prior commitments and obligations then the road can take a little longer, again, cooperation is key.

Overall, invoice factoring has a relatively simple application process which can be handled quickly. Great news to the gotta have it now environment we live in.

Accounts receivable factoring companies and most lenders in general are risk adverse. This means the factor is always considering how a purchase might go bad. Since the funding is based on the ability to collect on the invoice, anything at all that might go wrong is taken into consideration. For this reason a very thorough and deliberate process is in place to mitigate the potential problems that may arise when an invoice has been factored.

While our money is out on the street what potential scenarios could possibly occur that would prevent payment of the outstanding payment? It might seemed outlandish, but by taking these risks into consideration and possibly making preventative measures to alleviate the risk – it helps us sleep at night!

It may seem overly conservative or cautionary at times, but the factoring company has time and experience on their side to show that accounts receivable financing, done right, is a very safe way to leverage an asset.

The bottom line is, we owe it to our entire portfolio of clients who rely on our ability to fund to insure that we are doing everything possible to protect our ability to fund. Seeing comprehensive, tight due diligence in the financing process should telegraph to you that the factoring company is doing their best effort to make sure you have the working capital when you need it.

Once a business owner becomes aware of factoring they will have to consider whether to try and secure a line of credit from a bank or use accounts receivable financing to grow their company. When you get a loan from a bank, the amount of credit will always be limited to the historical ability to pay. The monthly payment is based on the probability it will leave enough profit to continue to run the business. Rarely do we find a business owner with the dedicated discipline to pull money out of the bank line and then go back and replace it when they get paid on an invoice. Essentially that is what a line of credit is for; to self factor your own receivables.

Instead, the LOC starts getting eaten up over time when cash flow is tight. After a while the workout department at the bank will set aside the old LOC as a term loan with monthly payments. Because the LOC was secured by the business assets of the company there is nowhere to go to get more capital until the note is paid in full.

In contrast, a factoring company is an excellent alternative for a company in a growth mode. By factoring your invoices the discipline is built in to the transaction and there is no top end credit limit, no need to requalify for increases to the line. As long as you grow and have fresh invoices you can always get funded. And when the invoice is paid by your customer, the transaction is completed. No long term liability that has to be retired.

This element of credit underwriting has come to light recently in some deals that I have in the works, so I thought I would write about it and encourage any feedback or comments from my readers. For those of you that are not familiar with the term, concentration risk in the context of this discussion is the risk a company has by having “too many eggs in one basket” so to speak. In C & I underwriting, when we analyze a business, we look for any one client that makes up greater than 20% of their revenue in a given period. We analyze this monthly, quarterly and annually. To further illustrate this point, let’s look at a revolving line of credit secured primarily by accounts receivable. Now each bank will have its own method of calculating a borrowing base for this type of credit, so please don’t try to “correct” me to match what you are familiar with. I am using generalizations based on my personal experience. For simplicity, lets say that you have a $1,000,000 revolving line that is secured by A/R at an 80% advance rate. That would mean you would need $1,250,000 in eligible A/R to have the full $1 million available. Most borrowing base reports will have a concentration exclusion of anything in excess of 20% to one account. In this example that would mean that any one A/R account that exceeds $250,000 would have the amount over 250,000 excluded. This is where the client jumps in “But Bill, that account is a fortune 500 company with a high credit rating, etc. etc., how can that be excluded?” Well the list goes on and on of Fortune 500 companies that have gone bankrupt over the years, but the concern in my mind is really not as much that, as it is you being too dependent on that one account. Additionally, I have seen cases where the much larger company the A/R is with, disputes the receivable due to work not being completed properly or specs not being right, etc., and it still can become uncollectable for a non credit reason.

So what is the point and who cares? If you have read this far, I bet you are thinking that. The point is, that if the bank is worried about a concentration in A/R maybe you should be too. I have read plenty of articles bashing banks and bankers and claiming we are not interested in helping businesses. With 15 years in the industry, I can tell you that is not true for me or many of my colleagues throughout the nation. At the end of the day, we are managing the risk to the bank of being repaid. In this case, your business would have that same risk that we are concerned about. So next time you are looking at that multi million dollar account that will catapult your business to the next level, just keep in mind that any account that can dramatically change your business can destroy it as well.

The difference between the fees associated with accounts receivable factoring and the Annual Percentage Rate (APR) commonly used when borrowing capital is the same as having a dog on a short leash or a long one. The long leash comes with a history of paying attention and maturity while a short leash means quick oversight and keeping out of trouble.

In other words it’s directly related to the small business being able to qualify for a bank loan. Either the financial condition of the company will allow securing a conventional loan or you have to seek funding elsewhere. A bank loan means significant assets available as collateral, profitability and sound management.

For our clients, a bank loan is the ultimate goal, but getting there requires outside capital. Strictly speaking, using accounts to fund using factoring is not a loan at all. The factor is purchasing the underlying value of the obligation from a creditworthy customer to pay an invoice. This is why the decision to fund is based on that customer’s credit.

A factoring transaction is much more than paying a monthly loan payment after qualifying for a loan. The short leash entails various staff activities that allow the factor to know within 30 days whether there is a problem with the account. Therefore, a factoring company does not lend money to a company for a year, it buys accounts receivable that in exchange requires a service charge based on the transaction.

The proper way for a small business to calculate the value of factoring is to first consider their profit margin on a sale. If deciding whether the company can afford to make the sale based on payment terms with the customer – will the factoring service charge allow the company to move forward faster by giving up a few points of profit? It’s not APR as a cost, but instead total annual profit increased by turning internal capital faster and more efficiently.

There are situations with factoring in which there is a critical mass of accounts, well over $250,000, where the possibility of shared collateral is sometimes utilized. It requires the absolute full cooperation of two lenders but the possibility exists and has been put to use in many occasions.

The term is called a carve out between two lenders. The first senior lender is usually a bank with a significant line of credit or term loan in place and is using the business assets as collateral. The second lender comes along after the borrower realizes it needs additional working capital to keep the business growing.

The need for having two separate lenders is based on the weakness of the financial condition of the borrower whereby the bank is not interested in furthering their commitment in loan value. Probably the borrower is not really considering the details, they only need more capital to keep going.

To explain what the carve out accomplishes here is a scenario where it would play out; the borrower company owns their own building and has $500,000 of current accounts receivable. The bank has a first position on the real estate and the accounts. A factoring company would propose that an inter-creditor agreement between the bank and the factor would allow the factor to have a first position on a portion of the accounts, for instance $100,000. This would allow the factoring of the first $100,000 of accounts which could give the borrower some badly needed breathing room.

One caveat that is often misinterpreted, the carve would be based on a dollar amount rather than particular customer accounts. Should one of those customers default, the factor would have no method to reclaim its advance. Using a dollar threshold instead gives the factor the ability to collect where needed to get paid off.

This is a highly technical and complex set of negotiations so if you think you might be a candidate for the sharing of accounts, please contact Creative Capital Associates for further consultation to see if the proposed scenario is feasible.

In this economy, how can accounts receivables factoring help growing companies?
Factoring is an increasingly popular financial tool that allows companies to collateralize the assets of their outstanding invoices. Whenever a business extends terms to a customer they essentially offer them credit. A factor enables the business to convert those invoices into immediate cash, allowing them to continue funding their daily operations. Accounts receivables from credit-worthy commercial clients are excellent collateral, especially when a company is in a growth mode. This makes it an ideal financing vehicle for small and mid size businesses. Many prime government contractors are finding the lack of access to capital restrictive to their overall performance success.

How does factoring work?

Check the quickest access to financing, invoice factoring companies use invoices as the basis for making cash advances. The factoring company finances invoices and provides funds immediately, while they wait to get paid by the client’s customers. Perhaps, this transaction is best described with an example:

1. Assume that a client sells products/services to various customers. As soon as they provide their services, they issue invoices.
2. Having previously checked the account debtors (customers) creditworthiness, the customer is notified to remit payments directly to the factor.
3. The factor wires funds to the client making an advance which is the percentage of the total amount. The advance is usually 70% – 85% depending on certain variables. The remaining percentage is called the reserve, which is held until payment is received.
4. The factoring company waits to get paid directly by the client’s customers. Once paid, the service fees are deducted from the reserve and the balance is sent on to the client. Each time an invoice has been paid the transaction is retired.

What issues affect the cost of accounts receivable factoring?

Typically the cost is determined on these criteria:
1. The creditworthiness of the customers.
2. The length of time invoices take to get paid.
3. The monthly factored volume.
4. What industry is involved? How does the business model work?
So the cost, called a discount rate or service charge, can be as low as 1.5% or as high as 3% for a 30 day outstanding invoice, per transaction depending on these criteria.

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